Until the Finance Act 2006 brought in changes to how trusts were taxed, the Accumulation & Maintenance (A&M) trust was an ideal solution for grandparents or parents wishing to make provision for minor children.
Providing the provisions of Inheritance Tax Act (IHTA)1984, S71 were satisfied, these arrangements offered a number of valuable benefits for clients wishing to make large gifts into trust for the benefit of minors. The conditions to be satisfied under S71 were that:
- The trust was established for children of a common grandparent (if this was not the case, it would only qualify for the favourable inheritance tax (IHT) treatment for a maximum of 25 years)
- No interest in possession had to exist in the settled property
- Beneficiaries had to achieve a vested interest by a specified age no greater than 25 (although this could be simply a right to income rather than an absolute entitlement to capital)
- Income from the trust arrangement had to be accumulated if not used for the maintenance, education or benefit of a beneficiary
- These minor restrictions were offset by the valuable tax advantages of these arrangements, namely:
- A gift to an A & M trust was a potentially exempt transfer (PET) rather than a chargeable lifetime transfer, allowing considerable gifts to be made without an immediate tax charge
- No periodic or exit charges applied as they do to trusts under the relevant property regime
For parents and grandparents considering trust investments, these arrangements offered significant advantages over the alternatives of straightforward bare or discretionary trusts. They:
- prevented beneficiaries from becoming absolutely entitled to assets at age 18 as they would under a bare trust
- avoided the relevant property tax treatment applicable to discretionary trusts
Schedule 20 of Finance Act 2006 completely overhauled the inheritance tax position of trusts with the result that it is no longer possible to create new A&M trusts with the same advantages. Existing trusts that remain in force are subject to the relevant property regime – unless they were varied to vest at age 18 (precisely what the settlor had wanted to avoid!).
Finance Act 2006 completely overhauled the inheritance tax position of trusts with the result that it is no longer possible to create new A&M trusts with the same advantages
Post Finance Act 2006, clients wishing to make gifts during their lifetime can choose between making a chargeable lifetime transfer into a discretionary trust or making a gift into a bare trust, which would automatically give the beneficiary access to the trust fund once they reached age 18.
The preferred option seems to be the use of a discretionary trust as many clients prefer to defer beneficiary’s entitlement to the trust fund to a later date, or at least have the ability to defer entitlement should they feel the beneficiary is not sufficiently mature to manage the assets appropriately.
There is now however a realistic alternative to the old A&M trusts, which provides that:
- The initial transfer into the trust is a PET
- All investment income is accumulated throughout the life of the plan. There is no requirement to pay ‘income’ out by a certain age
- An ‘income’ can be provided by way of maturing policies (the underlying asset is an investment bond which is a non income producing asset so this is not income in the true sense of the word)
- The trustees can use trust funds for the maintenance and education of the beneficiary as they could under an A&M trust
- The beneficiary can only receive benefits from the trust on a pre-determined date selected by the trustees which can be at any age up to a maximum age of 49
- This arrangement also offers the additional benefit of placing no restriction on the choice of class of beneficiaries
- And finally the investment vehicle is located offshore, so the investment accumulation is virtually tax-free. (Unrecoverable withholding tax is deducted from some dividend income.)
This arrangement is known as a controlled reversion trust (CRT). It is a concept that aims to allow lump sum payments (‘income’) for child beneficiaries at a time when they need it while allowing the donor to gift in excess of the IHT threshold without incurring an immediate tax liability.
It allows the trustees to decide before the child beneficiary reaches age18 at what age the child beneficiary should receive further lump sum payments. This provides the level of control required by the donor and the trustees can ensure the beneficiary receives appropriate amounts at the appropriate age.
The CRT is a bare trust and, therefore, there is no quasi nil-rate-band restriction on the amount gifted, no ten-yearly periodic charges and no exit charges.
Of course, the donor still has to live for seven years for the amount of the PET to be excluded from his death estate.
The major benefit of this type of arrangement is that the trustees can defer entitlement to capital well beyond the date the beneficiary reaches age 18, and throughout the lifetime of the trust they have the flexibility to determine the age at which the beneficiary should receive any benefits.
All in all, a straight replacement for the pre-2006 A&M trust.
Specialist investment product
So how can this all be achieved within the framework of a bare trust? The answer is not in the trust wording, but the specialist investment product that the trustees hold as an asset.
The product consists of a series of offshore investment policies with deferrable fixed maturity dates. The policies can be allowed to mature on the pre-determined policy anniversary or the maturity dates can be deferred if payments are not actually required for the child’s benefit at that time.
For example, Mr Brown wishes to provide for his only grandson Peter (currently aged 7) to fund his private education, university costs and beyond. He envisages that he can help Peter get on the housing ladder at a later date and give financial assistance when Peter has his own family.
He is aware that if he makes gifts at those particular times there could be an inheritance tax issue and what if he dies before then? Mr Brown wants to be happy in the knowledge that he has put plans in place to achieve his objectives in the most IHT efficient manner.
He decides to make a gift of GBP300,000 into a CRT and selects Peter’s parents as trustees along with himself.
The trustees purchase the investment policies, which are established to provide maturities over 15 consecutive years commencing when Peter is ten. The ‘income’ is provided by maturing policies in these years which have been sub-divided to allow greater flexibility in income during the life of the plan.
Prior to Peter’s 18th birthday, the trustees can vary the dates of the maturities allowing them to extend the final vesting dates if they feel it is appropriate.
Peter’s private education costs are GBP20,000 a year, therefore the trustees arrange for five policies (highlighted green) to mature each year from age ten for the next eight years with any investment growth taking care of any inflation in the school fees. If Peter’s tuition fees were only GBP16,000, four policies could be matured with the remaining one policy being deferred to a future date.
In the final year preceding Peter’s 18th birthday, the trustees have to make the decision as to when they want the remaining policies to mature. The policies highlighted in blue could therefore all be deferred to age 25 if Peter chooses not to go to university, or could be arranged to mature in consecutive years from age 25 until they have all matured.
In this example however, the trustees decide to defer the maturity dates to provide for Peter’s continuing education at university, then provide him with lump sums at ages 25 and 30 with the final balance payment at age 35.
The proceeds of any policies maturing after the child beneficiary’s 18th birthday have to be paid to the beneficiary, but as none of the policies have any surrender rights this makes it impossible for a child beneficiary reaching their 18th birthday to demand the encashment of the remaining policies.
As the likely donor will be either a grandparent or possibly a parent, it is important to note that there is a difference as to who is liable for the potential income tax liabilities on any maturing investment policies.
If the grandparent makes the gift, any potential liability always falls on the child as the bare trust beneficiary.
They will, therefore, usually have a personal allowance to offset against any gains.
Alternatively, if the parent makes the gift, any potential liability would fall on the parent until the child’s 18th birthday or their earlier marriage.
In summary, this arrangement can offer clients wishing to make provision for children or grandchildren all the benefits of an A&M trust without any of the restrictions. It offers the ability to make gifts in excess of the nil-rate-band with no immediate tax charge, no ongoing charges and no exit charges thus providing a viable solution to clients wishing to make IHT efficient lifetime gifts.
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